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Why Use Credit?
Much of the time, it is completely possible to go through life without having to touch credit, so why worry about it? The answer is that few of us can truly afford to purchase a new car or home with cash alone. The cost is simply too high and it is rare to find an individual who can drop $200,000 to buy a home. Often we have need for our own transportation or home long before we can save up enough money to buy them in cash. In cases like these, it simply makes sense to take out a loan and pay it back over time.
So we’ve accepted the fact that most of us will need to take out a loan at some point in our lives in order to finance, or pay for, major purchases. So why bother with credit cards or any other kind of credit in the meantime? Good question. The simple answer is that lenders won’t typically lend you an enormous amount of money, such as you might need for a home or car, unless they have some reason to believe that you will, in fact, pay that money back in a timely manner. It turns out that the best way to prove that you’ll pay the lender back is to demonstrate that you have a history of paying back lenders on time; in other words, you have to establish a good reputation. This kind of reputation is called credit history.
Without getting into too much detail, the best way to build up a positive credit history is to take out smaller loans and pay them back over time, whether by taking out an actual loan, or more commonly, by using a credit card and consistently paying back the borrowed money over time. There are companies called credit bureaus that keep track of your payment history on your credit card and any other kind of loan. These credit bureaus are the ones who keep track of your credit history, and when a lender is deciding whether or not to give you a home loan, he essentially contacts the credit bureau and asks to see your credit history. If your credit history indicates that you are a reliable borrower, then you have a much better chance of getting the home loan.
This process is actually a bit more complicated, but what matters right now is that you understand the basics of what’s going on; when someone is deciding whether or not to give you a loan they want to see if you’re the kind of person who will pay the money back!